Back to the Main ET Page

Have the reforms failed India?

ARVIND PANAGARIYA

 
The question “have the reforms failed India ” at a time when optimism in the country is at its peak seems out of context if not outright silly. Yet, this is precisely the challenge reforms-skeptics have posed recently.
 
For instance, distinguished economists Bradford DeLong of the University of California , Berkeley and Dani Rodrik of Harvard University separately argue that reforms cannot be credited with India ’s high growth rates in recent years because the shift in the growth rate preceded the reforms of the 1990s.
 
In a related but slightly different vein, economist Joseph Stiglitz contends that India is one of the two most impressive economies today (the other being
China ) and that India also, like China , has bought the least into the globalisation story that the IMF and others are selling.

A closer look at the evolution of growth and reforms in India reveals three facts that stand in sharp contrast to the DeLong-Rodrik story, however. First, growth during the 1980s took place in the context of significant reforms.  While the reforms were ad hoc and implemented quietly (“reforms by stealth” is the term often used to describe them), they made inroads into virtually all areas of industry and laid the basis for the more extensive July 1991 reforms.

Second, growth in the 1980s was fragile and varied significantly depending on the sub-period chosen. Because this growth was also partially driven by external and internal borrowing, it was unsustainable and crash-landed the economy in 1991.

Finally, the more systematic and systemic reforms of the 1990s produced decidedly more stable and sustainable growth from 1992 on.

And, in contrast to the Stiglitz view, India ’s reforms have been very much in line with the policies that mainstream economists and the IMF have traditionally advocated. Outward orientation, licence-free entry of firms, confinement of the public sector to public services and infrastructure while giving free entry to private-sector firms even in these sectors, privatisation, stable monetary policy, and fiscal discipline, which India has embraced or seeks to embrace, are all a part of the package pro-reform economists and IMF recommend.

True, the pace of India ’s reforms has been slower than what even many pro-reform economists who favour gradualism over shock therapy advocate, but this is to be attributed not so much to conscious choice as to the country’s democratic political process that demands consensus that is slow to build. In one area — capital account convertibility — India has deliberately chosen to go slowly, but many pro-globalisation and pro-reform economists, including the author, have explicitly advocated such a delay.

Returning to the DeLong-Rodrik thesis, contrast first the growth experience prior to and following the July 1991 reform. The accompanying chart shows growth rates from 1976-77 to 2002-03. Growth rates prior to 1992-93 — the year when the July 1991 reforms began to pay dividend — show distinctly greater volatility than those following it. The average growth rate from 1978-79 to 1987-88 turns out to be an unimpressive 4.1%, giving the impression that until 1988 India was still on the Hindu growth path. It is the high average growth rate of 7.6% during 1988-91 that makes the average growth in the 1980s comparable to that in the post-1991-reforms era.

In turn, the high growth rate during the last half of the 1980s took place in the presence of significant reforms. The Rajiv era reform included a rapid expansion of the open general licensing that allowed a quarter of the products to be imported without license by 1990; introduction of several east-Asian style export incentives that partially neutralised the impact of import protection; massive devaluation of the rupee in the second half of 1980s that aided the dramatic expansion of exports; replacement of multiple excise duties by a modified value-added tax; investment de-licensing in 31 industries with 27 still remaining; broad-banding that allowed firms to switch production between similar product lines such as trucks and cars; automatic expansion of production capacity upon achieving 80% capacity utilisation; abolition of price and distribution controls on cement and aluminum; and five-fold hike in the asset limit on firms subject to the purview of the Monopolies and Restrictive Trade Practices (MRTP) Act. This last reform freed many firms from MRTP restrictions and allowed them to take advantage of the new liberalisation measures.

Unfortunately, the steps that India took to liberalise its industrial and trade sectors tell only a part of the 1980s story. Rapidly rising borrowing at home and abroad also played an important role in fueling the growth. For example, foreign debt rose from $20.6 billion in 1980-81 to $64.4 billion in 1989-90. The debt-service payments as a proportion of exports rose from 18% in 1984-85 to 27% in 1989-90. Domestically, defence spending, interest payments, subsidies, and higher wages stoked public sector spending. During the first half of the 1980s, current expenditures of the combined central and state governments averaged 18.6% of GDP. By the second half of the decade, these expenditures averaged 23% of GDP. Combined fiscal deficits of the central and state governments rose from 8% of GDP in the first half of the 1980s to 10.1% of GDP in the second half. The eventual outcome of these developments was the June 1991 crisis.

The crisis notwithstanding, the experience of the 1980s emboldened the policy makers to turn the 1991 crisis into an opportunity for more systemic and systematic reforms. In turn these latter reforms have not failed to improve upon the performance of the 1980s. Whereas the 1980s growth was highly variable and fragile culminating in a balance of payments crisis, growth since 1992-93 has been robust with foreign exchange reserves hitting the $100-billion mark.

Reforms have not failed India ; instead, India has failed to reform enough. With deeper and faster reforms without giving up the essential gradualist approach, India can readily push the growth rate into double-digit levels.

Economic Times, December 31, 2003

.